Asymmetrical Information - Megan McArdle

Why Can’t Walmart Be More Like Costco?

Because they’re really very different

11.26.12 9:29 PM ET

One simply cannot have a discussion about Walmart's wages without someone bringing up Costco.  It seems to be de rigeur, like tipping your waiter, calling your mother on her birthday, and never starting your thank you notes with the words "Thank you".   So lets get it out of the way before the supper gong goes.

Obviously, there's a pretty pleasing narrative for labor activists: 

A Sam's Club employee starts at $10 and makes $12.50 after four and a half years. A new Costco employee, at $11 an hour, doesn't start out much better, but after four and a half years she makes $19.50 an hour. In addition to this, she receives something called an "extra check"—a bonus of more than $2,000 every six months. A cashier at Costco, after five years, makes about $40,000 a year. Health benefits are among the best in the industry, with workers paying only about 12 percent of their premiums out-of-pocket while Wal-Mart workers pay more than 40 percent.  

In response to this post, Matt Yglesias says that Costco's margins are lower than Walmart's, so pretty clearly, there's room for them to lower the margins and give the money to the workers.  Quite possibly so, but I'm not actually sure how well this argument really works. It would be a good argument in the case of, say, steel plants or automakers, where the business models are all about the same. But Walmart is not just a poor man's Costco. They're very different businesses, with very different labor models, demographics, and revenue streams. And those things work together: the fact that Costco is doing great with a given labor model or profit margin does not therefore mean that Walmart could easily follow the same course. With depressing regularity, you see pundits and activists asking "Why can't Walmart be more like Costco", which is a little like asking why Malcolm Gladwell can't be more like Michael Jordan. I mean . . . um . . . where do I even start?

How about with some basic figures about Costco and Walmart? I, er, just happen to have a handy little table right here.  Just something I threw together, you know.  No trouble at all.

* Includes Sam's Clubs

What do you notice?  Costco has a more highly paid labor force--but that labor force also brings in a lot more money.  Costco's labor force, paid $19 an hour, brings in three times as much revenue as a Walmart workforce paid somewhere between 50-60% of that.  (There's a bit of messiness to all these calculations, because of course both firms have employees who don't work in stores--but that's the majority of their workforce, so I'm going to assume that the differences come out in the wash.)

This is not because Costco treats its workers better, and therefore gets fantastic productivity out of them, though this is what you would think if you listened to very sincere union activists on NPR.  Rather, it's because their business model is inherently higher-productivity.  A typical Costco store has around 4,000 SKUs, most of which are stacked on pallets so that you can be your own stockboy.  A Walmart has 140,000 SKUs, which have to be tediously sorted, replaced on shelves, reordered, delivered, and so forth.  People tend to radically underestimate the costs imposed by complexity, because the management problems do not simply add up; they multiply.  

One way to think about this is Thanksgiving dinner: how come you, who are capable of getting a meal on the table 364 nights of the year, suddenly find yourself burning things, forgetting the creamed onions in the microwave, and bringing the mashed potatoes to the table a half an hour late? Because when you're cooking sixteen things instead of four, it is not the same as cooking four four-item meals.  There are all sorts of complex interactions involving things like heating times and oven space, and adding more people to the problem, while probably necessary, itself multiplies the complexities.

Walmart has tried to reduce ("rationalize") the number of SKUs, but they were forced to backtrack and restore over 8,000 items to their stores.  That's because most Costco shoppers are opportunity shoppers--they buy whatever is on sale at the moment, and supplement with frequent trips to the grocery store.  Many Walmart shoppers, on the other hand, rely on the store for the majority of their needs--it has to be everything to everyone.  That's really expensive, and it requires a lot of labor to keep track of all of those SKUs, figure out where to shelve them, etc. Walmart uses a lot more labor per sale than Costco does because it sells more than one kind of gum, and not always by the 24-pack.

You know how your husband hates going to Costco because you have to stand in line for twenty minutes?  That's another part of Costco's low labor costs.  Except for its very busiest days, like Black Friday, Walmart keeps more registers open, which speeds your passage through line, but also wastes expensive worker time standing at the checkout and waiting for people to come by.  Again, this is not just some idiosyncratic decision that the stores have made because, well, people are different: customers will wait in line at Costco because they don't go there very often.  At Walmart, which is many peoples' grocer, clothier, and auto supply shop, long lines would cost them a lot of business.

Costco's higher revenues are also a function of their demographic.  Costco shoppers have an average income of $85,000--not surprising, because Costco tends to locate itself in affluent suburbs. Walmart shoppers are what the firm calls "value driven shoppers" which is to say, there's not a lot of spare money lying around the house, just waiting for an opportunity to buy a 6-lb wheel of Camembert.  Value driven are very price conscious, and willing to forgoe things like service or artful displays in order to shave an extra 50 cents off the weekly shaving cream budget.  If you've been wondering why Walmart seems serenely unworried that last Friday's labor action will touch of a boycott, this is why.  If you took all the people in my twitter feed expressing excitement about a new era of labor organizing last Friday, I'd be very surprised to learn that they had spent as much as a thousand dollars between all of them at a Walmart last year.  

Meanwhile, to speak more directly to Matt's point, Costco's margins are lower than Walmart's because they're basically a grocer with a sideline in televisions and kitchen gadgets.  Margins are very slim in the grocery business: it's a big part of peoples' budgets, it's not particularly fun shopping, and people have a good sense of what the prices would be because they shop very frequently.  Plus the losses to shrinkage and spoilage are very high.  On the flip side, no matter how bad a recession gets, people still buy groceries, so those margins are pretty safe; if that weren't the case, we'd have lost all our grocers, along with our national dignity, in 2009.

Costco is doing very well for a grocer, but very poorly for a department store, the category to which Walmart technically belongs.  Target, the store that is most like Walmart (albeit with a younger, more upscale demographic), has a profit margin of 4.1%.  

One final thing that's worth pointing out is that Costco doesn't even make money selling the groceries and the six person hot-tubs.  Their annual membership fee revenue exceeds their net profit--which is to say that the actual business of selling stuff is operating at a loss.  They're charging you an annual fee to buy stuff at or near cost.  That's a model that works really well with their basically affluent customer base, and not incidentally, a model that allows you to worry a bit less about your cost of sales.  Sam's Club tries to do the same thing, but caters to a lower-income clientele and makes a lot less money despite having more stores.

The point of all of this is to say that while it might be true that Walmart could make more money by adopting Costco's labor model, there's no particular reason to think that this would be so.  The differences in their labor models are not just some sort of personal preference, or ideological choice*; they're responses to the way that labor needs to be deployed to do the quite different things that these stores do.  We say that "they're competitors" because they do compete with eachother in some markets, for a handful of SKUs.  But very few people could replace their trips to Costco with visits to Walmart, or vice versa.  Despite the superficial similarities (cheap stuff in large store) they're really very different, and you can no more graft one's labor model onto the other than you can buy a single pack of gum in the Costco checkout.  

This is, of course, a separate question from whether a union should force Walmart to change its labor model; I'm merely addressing Matt's claim that there's obviously plenty of room for Walmart to lower margins, and more importantly, the rather fatuous argument that they should obviously do it voluntarily because it's better for everyone--the evergreen platitudes that I have wearily begun thinking of as the "Costco Shows it's Possible" story.  Matt thankfully does not make that argument, but by God, everyone else does, so I'm afraid I've got a bit of pent up steam on the subject. Costco shows it's possible to be Costco and pay the wages that Costco pays.  They have not demonstrated that it is possible to be Dollar General while doing the same.

I don't necessarily have much of a takeaway here--other than "Megan has accumulated a lot of factoids about Walmart and Costco that she would like to inflict upon her audience"--though I supposed I'd argue that before you decide whether this will be on net a good thing, you'd want to know whether changing the labor model would mean changing the business model--whether emulating Costco's admirably high pay would also mean emulating its extremely lean staffing models.  That's something you need to know before you decide whether unionizing would, on net, make Walmart's 1.3 million US associates better off. 

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* So actually, Costco's labor model is partly an ideological choice; its founder and longtime CEO, James Sinegal, was a fairly committed progressive who paid himself a very modest salary.  (He did, of course, own a good bit of stock).  There is some question about whether this is going to continue long term; Sinegal overrode his executives on a bunch of stuff related to compensation.  One signal to pay attention to: the incoming CEO makes more than twice what Sinegal did, though his mid-high six-figure salary still pales in comparison to the CEO of Walmart.  

But whether or not Sinegal's ideology mattered, he would have had a hard time paying those kinds of salaries in a Walmart style operation, which is much more labor intensive, so that each extra dollar of wages cuts more deeply into the bottom line.